The most likely "end game" in Washington, in our estimation, is a last-minute pact to avert a "default."

Unfortunately, the end game may not spell the end of the fiscal drama that's been on display for years; a
new accord could defer many hard decisions for another day.

We continue to prefer stocks over bonds, cash, and inflation hedges. Of course, an equity-centric portfolio
requires fortitude, but the current situation shows that even U.S. Treasury bonds are not truly "riskless;"
investing necessarily entails risks.

We are conscious of President Coolidge's observation: "The chief business of the American people is
business." And so we continue to monitor Wall Street and Main Street, not just K Street and Congress.

As much of the nation started the week by observing Columbus Day, lawmakers in Washington were still
exploring the possibility of finding common ground over tax and spending policies. The partial shutdown
of the U.S. government is in its third week and the federal debt ceiling, which sits just under $16.7
trillion, has not been raised. By the end of this week, the U.S. Treasury Department says, the nation could
be unable to pay all of its bills—raising the possibility of the first default on U.S. Treasuries in the
nation's history. Specifically, the Treasury Department has estimated that October 17 may mark the end
of the line for its creative money-management efforts. To be sure, there is debate over the validity of that
deadline.

The nonpartisan Congressional Budget Office has estimated that the Treasury could continue to meet the
nation's obligations for at least a few days beyond the 17th. Some believe the "real deadline" is October
31. That said, Standard & Poor's has indicated that it is looking at the 17th as the deadline, threatening to
downgrade U.S. Treasuries if substantial progress is not made by that date. We hope and expect that
lawmakers are considering carefully that threat, along with warnings from international leaders about the
danger to financial markets and the global economy in the event of a U.S. default. The longer the political
theater persists, the greater the harm that's likely to come to the U.S. and global economies, including the
value of the U.S. dollar and consumer and business sentiment.

While détente among the highly polarized political parties seems unlikely, we similarly view the odds of a
default as low. We believe our elected representatives understand the grave consequences that almost
certainly would follow. The most likely scenario, in our estimation, is that our representatives will delay a
fiscal pact, even one that only temporarily addresses the largest issues of the day, for as long as
possible—each side in the meantime seeking to extract concessions from the other—before coming to
terms at the last possible moment and declaring "victory."

Lawmakers could approve a short-term increase in the debt ceiling, possibly while leaving portions of the
federal government shut down. Such a deal would allow time for more negotiations over longer-term
policy adjustments. Lawmakers may well be spurred by financial market movements. One day last week,
for example, the yield on one-month U.S. Treasury bills spiked from 0.01–0.02% to roughly 0.40%.
Longer-term Treasury yields have been far less volatile, implying that investors, in aggregate, have been
worried about the possibility of a short-term default but have been confident that lawmakers would
restore quickly the "full faith and credit" of the United States by repaying its debts. The yields of 90-day
T-bills, for example, remained in the 0.03–0.05% range.

Opportunity, perhaps, for volatility-tolerant, long-term investors
Our Investment Strategy Team recognizes the short-term impact that the discord in Washington is having
on financial markets and the economy. However, we believe current equity valuations are supported by
our forecast for long-term corporate earnings growth. On balance, we see no reason for long-term
investors with well-considered investment plans to alter their portfolios based on the goings-on, or lack of
them, in Washington. Investors may not go en masse into "risk-off" mode—selling risky assets in
meaningful quantities—unless it looks as if the U.S. debt ceiling will not be raised "on time."
Unfortunately, given conflicting views and messages about when the Treasury might cease to be able to
make good on critical obligations, such as debt or Social Security payments, investors could try to "front
run" any fiscal calamity—meaning that markets could be remarkably volatile this week and may remain
so for as long as the "end game" remains unclear.

In the context of such uncertainty, there could be an opportunity for volatility-tolerant, long-term
investors who are underweight their target equity allocations to buy stocks on a sharp pullback in the
coming days. On the other hand, investors planning to meet spending plans or commitments with the
proceeds of individual Treasuries due to mature in the coming days or weeks should be actively
considering other funding options. Likewise, investors whose nerves are frayed by Washington's
approach to fiscal policy and tempted to sell much or all of their holdings of risky assets should consider
whether their investment strategy accurately reflects their risk tolerance. One of the most important roles
played by our Investment Advisors and Officers is helping clients to select suitable mixes of financial
assets.

We are confident that, before too long, there will be a "long-term" increase in the debt ceiling—perhaps
authorizing Treasury payments for another 12 months or so—and that a continuing resolution will be
passed to return government workers to their posts. We have limited confidence in our ability to predict
the exact timing of the adoption of such policies.

For the long term, we continue to prefer stocks over bonds, cash, and inflation hedges. Of course, an
equity-centric portfolio requires fortitude, but the current situation shows that even U.S. Treasury bonds
are not truly "riskless;" all investing necessarily entails risks.

Remember the Federal Reserve?
Lost amid the headlines about D.C.'s fiscal fight was President Obama's nomination, on October 9, of
current FOMC vice chair Janet Yellen to succeed Ben Bernanke as chief of the nation's central bank.
Bernanke's second four-year term expires on January 31. We would not expect major changes in Fed
policy under Yellen, assuming that she is confirmed by the U.S. Senate.

Beyond the Beltway
Washington has been grabbing all of the headlines of late, but federal, state, and local government
spending accounts, in aggregate, for only about one-fifth of the goods and services produced in the United
States. We have not forgotten that the prospects for corporate earnings and economic growth underpin the
value of many risky assets. In brief, we expect profits to continue to grow, if modestly, and the tepid U.S.
economic recovery to continue, barring disaster on the fiscal policy front. To be sure, we are actively
monitoring the situation in Washington, but also corporate profitability and the broader economy.

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